Budget woes are no surprise

The real surprise about the warning by Treasurer
Wayne Swan
that budget revenues have been hit by a sledgehammer is that Mr Swan and the Treasury have been caught out by it. For a decade, the rest of the world gave us a pay rise every year. Now the rest of the world is taking this back. Neither Mr Swan nor Opposition Leader
Tony Abbott
wants to face up to what this means.

The essential budget problem is that growth in so-called nominal gross domestic product, or the money value of what the economy produces, has slipped below the growth of real GDP, the physical volume of what the economy produces. That’s a problem for the budget because the taxes extracted from wages and profits are driven by nominal, not real, GDP.

Nominal GDP normally grows faster than real GDP because it includes inflation. On average, the economy is capable of ­producing a bit more than 3 per cent or more widgets, houses, haircuts, wheat, iron ore and so on each year. But the nominal value of this GDP may grow 5-6 per cent because it includes 2-3 per cent price inflation.

That’s in normal times. When the mining boom kicked in about a decade ago, nominal GDP growth accelerated to 7-9 per cent because the Chinese and other Asian buyers were prepared to pay us three or four times more for a big part of what we produced – iron ore and coal. This nominal GDP boom produced a surge in tax revenues that helped generate the budget surpluses of the Howard-Costello era. Other unsustainable factors, including the capital gains tax paid on a booming stockmarket, also helped.

After the interruption of the global financial crisis, iron ore and coal prices rebounded, pushing the economy’s terms of trade (the ratio of export prices to import prices) to their highest peak in at least 170 years. But for the past year, iron ore and coal prices have been falling. After more than doubling over a decade, the terms of trade have fallen 14 per cent in the past year. The economy has been growing in physical terms at close to its 3 per cent annual sustainable trend. But rather than expanding faster than real GDP, nominal GDP has slowed sharply to 2 per cent. And that’s clipped growth in tax revenue, forcing Mr Swan to dump his much-promised budget surplus this year, and perhaps for the few years after this.

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Rather than being a bolt from the blue, this slump in tax ­revenue ought to have been anticipated. Treasury secretary
Martin Parkinson
has been warning for the past year that Canberra had become addicted to a burst tax revenue bubble. This is a way of saying that the federal budget is stuck in an entrenched structural deficit camouflaged by high iron ore and coal prices. Yet, with one exception, Mr Swan’s budgets have excluded discussion of the structural budget position. And they have included no serious analysis of the risks to a budget bottom line propped up by a 170-year plus high in commodity export prices. It’s no wonder that Labor’s stated medium-term fiscal policy, to run surpluses over the course of the economic cycle, is looking like a long-term pipe dream.

So now the budget looks set to clock up at least six years of successive deficits totalling $170 billion or so when our export prices have been at or close to record highs. We should have been squirrelling away surplus funds for the tougher times that may be coming. Instead, Labor continues to build in new budget-spending momentum, financed by non-existent tax revenue. As the Grattan Institute suggests in its analysis, Australia was among the many countries that have wasted the good times.

Significant pressures loom. Health spending that has jumped by over $40 billion in real terms in the last decade poses big problems when an electorate has got used to hearing that no budget measure will make anyone worse off and the country can afford to increase spending on a disability insurance scheme, on education and more parental leave. In fact the opposite is true, and Mr Swan should have seen it coming.